Next Macro Regime Shift Promises to Turn Goldilocks Upside-Down

The macroeconomic backdrop of the past year is about to be turned on its head, warns Morgan Stanley.

“After 12 months of falling core inflation and rising global PMIs, we are set to enter a period of rising core inflation and (likely) declining PMIs,” writes cross-asset strategist Andrew Sheets. “That’s a major change, and prior instances of ‘inflation up, PMIs down’ (2000, late 2007 and 2011) also caused volatility.”

Markets have traditionally been well-equipped to handle higher inflation when it comes alongside a pickup in growth, notes Sheets. But it’s the prospect of an inflection point away from the dominant narrative of “synchronized global growth” reflected in rising PMIs, and moribund price pressures that could cause investors angst.

“I’d stress that our concern isn’t about levels. It’s about direction, and extrapolation of that direction,” cautions Sheets, noting that inflation will likely remain below target and PMIs in expansionary territory. “This is going to look like a very tempting trend to extrapolate, at a time when mean-reverting indicators like PMI and economic surprise indices are likely to be falling back to more normal levels.”

In other words, wave goodbye to Goldilocks -- that enjoyable environment for risk assets that featured strengthening growth while inflation and bond yields remain subdued. One sign that we may have passed “peak” Goldilocks: mentions of the term in news articles tumbled to single-digits the week ending March 2, from a prior reading of 68.

Investors also fled the cyclically sensitive Industrial Select Sector SPDR Fund (ticker XLI) for the sixth straight week after U.S. President Donald Trump warned of imminent tariffs on inbound steel and aluminum. Strategists fret that an escalation of border thickening may dampen global activity and raise consumer prices. That’s the longest stretch of withdrawals for this product since the third quarter of 2014, following a supply-side-driven collapse in oil prices that coincided with a softening in gauges of manufacturing output.

Morgan Stanley recommends maintaining overweight positions in energy and financials, two inflation-sensitive segments of the equity universe.

    Quotes from this Article
    Before it's here, it's on the Bloomberg Terminal.
    LEARN MORE